Young, Self-employed, and Trying to Buy a Home: Part Two (Saving for a Down Payment)

This is part 2 of our series on home buying when you're a young adult and self-employed (or just have irregular income). Check out our first post about the topic, where we explore why we're looking to buy and offer a bit of background on our whole situation.

DOWN PAYMENT INTRO

Saving for a down payment isn't typically an easy task for anyone - and if it was an easy task for you then totally feel free to contact us for our PayPal email address, thanks! Saving for a down payment when you have to self-report your own taxes, have irregular income, and compounding student loan debt to pay off? It can get really difficult.

First - because this is supposed to be useful for even the folks brand new to the housing market - let's get into exactly what a down payment is. This is basically all the shit we should've learned in high school but didn't, explained. When you buy a home, assuming you aren't just loaded and paying for it in cash, you're really just asking a bank to buy the home for you with the promise that you'll pay the bank back in monthly installments called a mortgage. Think of it like a huge credit card, where instead of having a bank give you a little piece of plastic that they allow you to spend a certain amount of dollars on with the promise of being paid back with a monthly bill, you're asking them to buy you a house. Just like with credit cards, there's interest on your unpaid balance that you'll be paying off with your monthly payments.

A part of the total cost of your home is paid for upfront and will not be included in those monthly payments: this is the down payment. For example, let's say you're buying a $200,000 house and planning to put 10% down, your down payment would be $20,000 and you'd be asking the bank to spot you for the remaining $180,000 which you'd be paying back each month with interest.

As for how much to expect to put down, pretty much everyone I've spoken to who was a first time home buyer over a decade ago will tell you around 20% is normal. That's a great goal and still required by many banks and lenders, but it's become increasingly unrealistic. With the onslaught of the 2008 recession, the normalization of student loan debt being in the tens of thousands of dollars for most young folks, and entry level wages not matching inflation* ... most young people are not going to have 20% down on a home and the banks are fully aware of this and they're also aware that if they want your money they're gonna need to be flexible for how to get it.

*This is worth exploring for another time, but after multiple free and underpaid internships during and after earning my undergraduate degree, most of the jobs I was being offered in media were between $28,000 - $32,000 a year for full time salaried employment (read: expected to be there 50+ hours a week). After taxes, this means my monthly rent would be eating a little over half of my pay, which can quickly become unsustainable when you factor in other monthly debts. Read more on income:rent ratio ideals, here. This is one of the reasons I took the plunge of self-employment in the first place, with my backup being working in the service industry.

If you're a baby boomer who thinks I'm just complaining, one: you're right, I'm complaining. But two: its not unfounded. According to literally the U.S. census:

Medium income in 1995 was around $33,000 while average home costs were at roughly $155,000

Median income in 2015 was around $56,000, while average home costs were at $350,000 (and this income was seen as the first huge increase in median income in years)

This means that during the years many of today's young adults were growing up and coming into adulthood, income increased 70% but home prices increased 126%. That ain't even, y'all.

HOW MUCH WILL I PAY?

So, what's realistic to pay for a down payment as a first time home buyer? Some traditional banks will let you go as low as 8%, and there are government backed loan programs (such as FHA home loans) requiring a down payment of only 3.5%. This is the loan program we're actually looking at using. There are certainly down sides to putting down less money - mostly that a large chunk of your monthly mortgage payments will be put towards the interest, but for some people it's really the best option.

To give you an idea of what 3.5% down looks like: math?

Let's say you're looking for a moderately priced home at $250,000 (remember median home cost is currently $350,000). Through an FHA loan program, your 3.5% down payment would mean (250,000 x .035) = $8,750 down. That's less than $10,000 upfront before you consider closing costs and insurance etc. It's not *the easiest thing in the world* - but it's not completely intangible for most folks who are earning a semi-standard salary and who are willing to save for a year or two.

As we've mentioned before, we're looking at buying a renovation project (i.e. a home that hasn't been touched since Hurricane Katrina) that we can really transform into a home that fits exactly what we want. There's a branch of FHA loans known as FHA 203k that deal solely with homes that need construction. These loans include a portion of the loan to go towards construction and renovation, which you'll pay off as part of your monthly mortgage. I won't get into this fully right now, but what it basically means is that the homes we're looking at buying are between $80,000 and $150,000 and at 3.5% down we're looking at a down payment of between roughly $3,000 and $6,000.* Discovering that this was an option is one of the main reasons we decided to jump into the home buying process in the first place.

*Note: With the FHA 203k loan, you'll be getting an appraisal for how much constructions costs are, and then paying your down payment for the full cost of the hoe loan + construction loan So, if we buy a $80,000 home that needs $50,000 of work, we're looking at paying a down payment of 3.5% on $130,000 - which comes out to $4,450.

Even if you are looking at buying a home at the average price of $350,000, an FHA loan would allow you to put down just around $13,000 - which, again, isn't easy for everyone by any means, but it's also not completely insane.

SAVING FOR YOUR DOWN PAYMENT

If you're not going the route of a reduced down payment program and are trying to buy a move-in ready home at 20% down, I don't know what to tell you that sounds awesome and I'm sure you've figured out a method of saving that is beyond anything I've got to say.

If you're looking at a reduced down payment program and are looking at homes either on the cheaper side or that are renovation projects, you're likely looking at trying to save up less than $10,000. There are a lot of reasons you should try and put away a bit more than just your down payment (emergency funds, mostly, are super important when you're buying a piece of property), but if we're focusing on saving that $10k there are a few tools that can help you reach that goal.

Start Yesterday

Buying a home isn't really something that should be jumped into, and to make your life easier it's best to start saving at least a couple of years out. Of course, if we're talking in terms of these super low down payment options, you really may only need 6 months or a year of saving to reach your goal. Maybe you've already been saving and are just now deciding to a buy a home - go you! For the rest of us, look at homes in the neighborhood you'd like to buy in and map out how much you'd need to save each month to meet that goal within a set amount of time, whether it's 6, 12, 18, 24 months of longer - this will be your timeline for when you can plan to buy.

Divide your income immediately upon receiving it

If you're self-employed like we are, you'll likely be having to report your own taxes. Since the money you receive from your clients won't have taxes taken out, you should typically be paying taxes every quarter based on basically a guesstimate that will then get sorted out at the end of the year. You can use a program such as TurboTax to track what your self-reported quarterly taxes should be. What this means is that it's best to automatically set aside a portion (say, 10%) of each payment into savings for your taxes each quarter. Why stop there, though? Open a separate savings account solely for your down payment, and automatically deposit another portion of each check into that account. A great online bank to go through for this is Ally, which offers a 1% apr and will likely be separate from your checking account meaning easy transfers out of your savings won't be a thing.

Make a budget and stick to it

You can do this the old fashioned pen-and-paper way, but people our age tend to suck at keeping that kind of thing straight, so a big YASSS goes out to apps like Mint. This app links to your cards and literally tracks every penny you spend and occasionally yells at you when you go over your budgeted amount for certain items such as food and drink or entertainment. It helps keep you in check and makes the process of seeing where your money is going a whole lot easier.

Eliminate unnecessary expenses

I know, I know, it sounds so obvious! But try to isolate the payments you don't think about, your small auto-withdrawn payments for simple services. For example, we almost never watch TV shows, but for some reason we were paying $12/month for Hulu before cancelling recently. That doesn't sounds like a lot, but think of what, say, four unassuming services at that price would cost you over a six month period: 4 x 12 x 6 = $288 saved. If you draw happiness from your streaming subscriptions, by all means keep them, but be thinking about other monthly payments you could stand to drop to get you to your savings goal even faster.

Let us know if you've got any tips to start saving for a down payment!